Notesale: Turn your study into money

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Introduction
The IASB Conceptual Framework states that an element (asset, liability, equity, income or
expense) should be recognised in the statement of financial position or statement of
comprehensive income when it:



meets the definition of an element; and also
satisfies certain criteria for recognition which is:
o It must be probable that the future economic benefit associated with the item
will flow either into or out of the entity
...


Items that fail to meet the criteria for recognition should not be included in the financial
statements
...


Probability of future economic benefit flowing in or out
The concept of probability relates to the degree of certainty or uncertainty that the future
economic benefit associated with the item will flow into or out of the entity
...

For example, if it is considered fairly certain that a trade receivable will be paid at a future date, it
is appropriate to recognise the receivable as an asset in the statement of financial position
...
It would then be
appropriate to recognise an ‘expense’ for the expected reduction in economic benefits (as an
allowance for doubtful debts)
...

In many cases, the value of an item has to be estimated because its value is not known
with certainty
...

However, if it is not possible to make a reasonable estimate, the item should be excluded
from the statement of financial position and statement of comprehensive income
...


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Recognition of assets
An asset is recognised in the statement of financial position when there is an increase in future
economic benefits relating:
 to an increase in an asset
 or a reduction in a liability which can be measured reliably
...
Instead, the item should be treated as an
expense, and its cost should be ‘written off’
...

Recognition of income
Income is recognised in the statement of comprehensive income when an increase in future
economic benefit arises from an increase in an asset (or a reduction in a liability) and this can be
measured reliably
...
It is what has been called a ‘balance sheet approach’ to income
and expense recognition
...

Recognition of expenses
Expenses are recognised in the statement of comprehensive income when a decrease in future
economic benefit arises from a decrease in an asset or an increase in a liability, which can be
measured reliably
...

Revenue is income that arises in the ordinary course of activities and it is referred to by a variety
of different names including:
In relation to 1 and 2, there is
1
...
Fees/Revenue derived from rendering of services
3
...
dividends
service agreements
...
royalties
IAS 18 Revenue defines revenue as
“The gross inflow of economic benefits during the period in the course of the ordinary activities
of an entity,
when those inflows result in increases in equity,
other than increases relating to contributions from equity participants
...
Amounts collected on behalf of a third party, such as sales tax collected on behalf of the
government, must be excluded from revenue because they do not result in an increase in equity
...

Broadly speaking, this is the:
Fair market price less any volume rebates (discount allowed for buying in large quantities) or
‘trade discount allowed’
...




If a sale is a cash sale, the revenue is the immediate proceeds of the sale
...


However, in some cases when the payment is deferred, the fair value might be less than the
amount of cash that will eventually be received
...

This interest income is also known as imputed interest
...
The entity has transferred to the buyer the ‘significant risks and rewards of ownership of
the goods’
...

2
...

3
...

4
...

5
...


Risks and rewards of ownership
Transfer of risks and rewards of ownership is critical to revenue recognition
...
However this is not always the case
...

1
...
g
...
The receipt of revenue may be contingent on the buyer selling the goods on;
3
...
The buyer has the right to rescind and the seller is uncertain about the outcome
...

Elaboration for Point 2
Consignment sales under which the recipient undertakes to sell the goods on behalf of the shipper
Revenue is recognized by the shipper when the goods are sold by the recipient to a third party
...


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If installation and inspection are not significant part of the transaction, Revenue is normally
recognized at the date of delivery of goods
...


Case 2: If legal title does not pass but the risks and rewards do, a sale is recognised
...


A seller may retain the legal title to the goods to protect the collectability of the amount
due but if the entity has transferred the significant risks (but insignificant risks might be
retained) and reward of ownership, the transaction is a sale and revenue is recognised
...
A seller may offer a refund if the customer is not satisfied
...

Elaboration for Point 2
Suppose
Total Sales for year = Rs
...
2,000
Revenue recognized in Trading a/c = 98,000
Liability in Balance Sheet – Provision for Sales returns shown as Rs
...


Cost recognition
Revenue and expenses must be recognised simultaneously
...

Revenue cannot be measured when the related expenses cannot be measured reliably
...


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Lay away sales
This is a term given to a situation where goods are delivered only when the buyer makes the final
payment in a series of instalments
...

Revenue from such sales is recognised when the goods are delivered
...
e
...
when a significant deposit is received,
2
...
identified and
4
...
when experience indicates that most such sales will actually proceed to completion/Sales
will Materialise/consummated
Examples from the book:

Subscriptions to publications
Where a series of publications is subscribed to and each publication is of a similar value revenue is
recognised on a straight-line basis over the period in which the publications are despatched
...
100
Amount of publications done in the year = 4
Amount to be recognized = (4/12) X 100 = Rs
...
33
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If the value of each publication varies revenue is recognised on the basis of the sales value in
relation to the estimated sales value of all items covered by the subscription
...

Total Sales value of items despatched = 350 Rs
...

Total Revenue Recognized = (350 /1600) *1000 = 219 Rs
...

This means that preparers must observe the principle of ‘substance over form’ by recognising the
economic substance of transactions where this is different from their legal form
...

Such a transaction may or may not be a sale depending on the substance of the agreement
...

Example:
A wine producer who creates a charge on his inventory of wine so that he may gain finance for
producing more wine
...

For example: The goods are still to be manufactured or will be delivered directly to the customer
from a third party
...


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Case2: Sales to intermediate parties for example: distributor, dealers, agents or others for resale
...

However, when the buyer is acting in substance as an agent, the sale is treated as consignment
sales
...
)

Case3: Bail and hold sales in which delivery is delayed at the buyer’s request but the buyer takes title
and accepts billing with acknowledgment
...

Rule: Revenue is recognised when the buyer takes title provided that:
1
...
Is ready for delivery to the buyer

Case4: Instalment sales under which consideration is receivable in instalments
...

 The sale price is present value of the consideration determined by discounting the
instalments receivable at the imputed rate of interest
...

Example: (Based on assumed values)
Value of instalments per year receivable = 5 Rs
...

Present Value = 20 Rs
...
20 Rs
Sales Cr
...

Year end from Year 1 to 5 – Cash Dr
...
4 Rs
...
1 Re
...


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Part 2: Revenue recognition from providing a service
Case1: Outcome of a Service can be measured reliably
When an entity provides a service to a customer, and the outcome of the transaction can be
estimated reliably, revenue should be recognised by reference to the stage of completion of the
transaction at the reporting date
...

IAS 18 states that the outcome of a service transaction can be estimated reliably when all the
following conditions apply:
 The amount of revenue can be measured reliably
...

 The stage of completion of the transaction at the reporting date can be measured
reliably
...

There is no single approach specified for determining the stage of completion
...
Possible approaches include (but are
not limited to):
 surveys of work performed;
 services performed to date as a percentage of total services to be performed; or
 the proportion of costs incurred to date to the estimated total costs of the transaction
...

Application of Case2: Advertising Commissions
Media commissions (e
...
payment for a series of adverts) should be recognised when the related
advertisement or commercial appears before the public
...

Application of Case3: Tuition Fees
Revenue should be recognised over a period of time (the period of instruction), in
line with the way the services are provided over that period of time
...

Only the expenses that are recoverable can be recorded as revenue
...

For Example:
There is no assurity about completion of a software package’s programming because of it’s
complexity
...

Example from the book:

Agency


A person or company might act for another company
...


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






An agent might sell goods for a principal and collect the cash from the sale
...

The agent is providing a selling service to the principal
...

An entity acts as principal only where it is exposed to the significant risks and rewards
associated with the sale of goods
...

The risks and rewards to be considered include:
o Responsibility for fulfilling the order
o Inventory risk
o Ability to set the selling price
o Credit risk (The occurrence of a bad debt)
Any unsold inventory left with Agent will be treated as Inventory held on behalf of 3rd
Party and the principal will treat it as his closing inventory
...

The franchisor provides the franchises with a licensed right to carry out a business activity under
the franchisor’s name
...

The franchisor provides services such as training and marketing and supplies inventory to the
franchisee
...

The franchisor must recognise franchise fees in a way that reflects the purpose for which the fee
is charged
...

Management service: On a monthly (or any other in respect of frequency of amounts
received from franchisee) basis
...

Quarterly fee (Usually a fixed percentage of franchisee’s gross revenue) : As earned in
relation to sales made
...


Case2: Installation fees
Rule:
If they are incidental to sale of a product, they are recognized when goods are sold
...


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Part3: Revenue recognition from sales of goods with service agreements/service
be included in the price of the product
Sometimes it is necessary to apply the recognition criteria to the separately identifiable
components of a single transaction in order to reflect the substance of the transaction
...

The amount deferred should be sufficient to cover both:
1
...
A reasonable profit
Example from the book:

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Part 4-6 : Other revenue recognition: interest, royalties and dividends
...
it is probable that the benefits will flow to the entity and
2
...


Interest
Interest income should be recognised on a time proportion basis that takes into account the
effective yield on the interest-earning asset
...
e
...

Revenue from royalties should be recognised:
1
...
in accordance with the terms of the royalty agreement
...

Right to receive dividend is established when (as explained in the following example)
Assume Company A owns shares in company B
...

If company B operates in a jurisdiction where there is no requirement for further approval
before a dividend is paid, then company A’s right to receive dividend is established at the
time dividend is declared

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